Chapter 3

Industry Analysis: Positioning the Firm in a Specific Environment

I. What is Industry Analysis

 Industry analysis- is a tool that facilitates a company's understanding of its position relative to other
companies that produce similar products or services. Understanding the forces at work in the overall
industry is an important component of effective strategic planning. Industry analysis enables small
business owners to identify the threats and opportunities facing their businesses, and to focus their
resources on developing unique capabilities that could lead to a competitive advantage.
 Understanding your industry directly impacts your ability to succeed. Understanding your industry and
anticipating its future trends and directions gives you the knowledge you need to react and control your
portion of that industry.
 Since both you and your competitors are in the same industry, the key is in finding the differing abilities
between you and the competition in dealing with the industry forces that impact you. If you can identify
abilities you have that are superior to competitors, you can use that ability to establish a competitive
advantage.
 Industry analysis can help you create long-term strategies, see threats before they reach you and
discover opportunities before they pass you by. Your analysis is relative, so compare yourself to
competitors and the rest of your industry to figure out how each of you deals with the forces in your
industry.

 Elements: Industry analysis is an important step in the business decision-making process. An

industry analysis covers history, overview, competitive structure, major markets, supply chain,
technology, major players, regulations, critical success factors and outlook. Industry reports
summarize an industry including both weaknesses and strengths. In contrast to general reports, a
specific industry analysis focuses on just one issue, such as growth.

 Significance: Industry analysis helps a company understand its position relative to companies that
produce similar products or services, the online site Reference for Business states. Better
understanding leads to more informed and better quality business decisions. This knowledge points
out threats and opportunities that could lead to the downfall or increased growth of your business,
so this understanding is an important part of both long-term and short-term planning.

 Process: Industry analysis starts with investigating secondary sources, follows with primary sources,
and organizes the information in a report. Secondary sources include databases, industry
publications, trade magazines and newspapers, and focuses on broad strokes of information.
Primary sources consist of industry professionals and customers interviewed directly or via
questionnaires for more detailed and specific information.

 Expert Insight: A widely used tool for analyzing an industry originated in Michael E. Porter's
“Competitive Strategy: Techniques for Analyzing Industries and Competitors,” published in 1980.
Porter listed five competitive forces that work together on every market and industry: ease of entry,
power of suppliers, power of buyers, availability of substitutes and availability of competitors. The
forces affect an industry’s structure and direction, highlights the strengths and weaknesses of a
small business and show potential strategic changes, Reference for Business states.

 Considerations: Porter’s first factor, ease of entry, depends on two factors: barriers to market entry
in the industry and how existing businesses react to new competitors. Also consider how much
pressure suppliers can put on your business and how many options you have. Weigh how much
power buyers have based on number of buyers, importance of product and purchase volume. Find
out how easy or how likely it is for the customer to switch to your competitor's product: if there are
 many similar alternatives, you can lose customers more easily. Finally, ask how intense the
competition is; highly competitive industries tend to earn low returns given the cost of competition,
Investopedia states.

II. 3 Major Elements

Industry analysis consists of three major elements:
1. The underlying forces at work in the industry.
2. The overall attractiveness of the industry.
3. The critical factors that determine a company's success within the industry.

1.1 INDUSTRY FORCES- The first step in performing an industry analysis is to assess the impact of
Porter's five forces. "The collective strength of these forces determines the ultimate profit potential
in the industry, where profit potential is measured in terms of long term return on invested capital,"
Porter stated. "The goal of competitive strategy for a business unit in an industry is to find a position
in the industry where the company can best defend itself against these competitive forces or can
influence them in its favor." Understanding the underlying forces determining the structure of the
industry can highlight the strengths and weaknesses of a small business, show where strategic
changes can make the greatest difference, and illuminate areas where industry trends may turn into
opportunities or threats.

(Note: Porter's Five Forces Framework is a tool for analyzing competition of a business. It draws
from industrial organization (IO) economics to derive five forces that determine the competitive
intensity and, therefore, the attractiveness (or lack of it) of an industry in terms of its profitability. An
"unattractive" industry is one in which the effect of these five forces reduces overall profitability. The
most unattractive industry would be one approaching "pure competition", in which available profits for
all firms are driven to normal profit levels.)

(Michael Eugene Porter is an American academic known for his theories on economics, business
strategy, and social causes.)

The Industry Forces: (Porter’s Five Forces)

1. Ease of Entry - Ease of entry refers to how easy or difficult it is for a new firm to begin
competing in the industry. The ease of entry into an industry is important because it
determines the likelihood that a company will face new competitors. In industries that
are easy to enter, sources of competitive advantage tend to wane quickly. On the other
hand, in industries that are difficult to enter, sources of competitive advantage last
longer, and firms also tend to benefit from having a constant set of competitors.
- The ease of entry into an industry depends upon two factors: the reaction of existing
competitors to new entrants; and the barriers to market entry that prevail in the
industry. Existing competitors are most likely to react strongly against new entrants
when there is a history of such behavior, when the competitors have invested
substantial resources in the industry, and when the industry is characterized by slow
growth. Some of the major barriers to market entry include economies of scale, high
capital requirements, switching costs for the customer, limited access to the channels of
distribution, a high degree of product differentiation, and restrictive government
policies.

2. Power of Suppliers - Suppliers can gain bargaining power within an industry through a
number of different situations. For example, suppliers gain power when an industry
relies on just a few suppliers, when there are no substitutes available for the suppliers'
product, when there are switching costs associated with changing suppliers, when each
purchaser accounts for just a small portion of the suppliers' business, and when
 suppliers have the resources to move forward in the chain of distribution and take on
the role of their customers. Supplier power can affect the relationship between a small
business and its customers by influencing the quality and price of the final product. "All
of these factors combined will affect your ability to compete," Cook noted. "They will
impact your ability to use your supplier relationship to establish competitive advantages
with your customers."

3. Power of Buyers - The reverse situation occurs when bargaining power rests in the
hands of buyers. Powerful buyers can exert pressure on small businesses by demanding
lower prices, higher quality, or additional services, or by playing competitors off one
another. The power of buyers tends to increase when single customers account for large
volumes of the business's product, when a substitute are available for the product,
when the costs associated with switching suppliers are low, and when buyers possess
the resources to move backward in the chain of distribution.

4. Availability of Substitutes - "All firms in an industry are competing, in a broad sense,

with industries producing substitute products. Substitutes limit the potential returns of
an industry by placing a ceiling on the prices firms in the industry can profitably charge,"
Porter explained. Product substitution occurs when a small business's customer comes
to believe that a similar product can perform the same function at a better price.
Substitution can be subtle—for example, insurance agents have gradually moved into
the investment field formerly controlled by financial planners—or sudden—for example,
compact disc technology has taken the place of vinyl record albums. The main defense
available against substitution is product differentiation. By forming a deep
understanding of the customer, some companies are able to create demand specifically
for their products.

5. Competitors- "The battle you wage against competitors is one of the strongest industry
forces with which you contend," according to Cook. Competitive battles can take the
form of price wars, advertising campaigns, new product introductions, or expanded
service offerings—all of which can reduce the profitability of firms within an industry.
The intensity of competition tends to increase when an industry is characterized by a
number of well-balanced competitors, a slow rate of industry growth, high fixed costs,
or a lack of differentiation between products. Another factor increasing the intensity of
competition is high exit barriers—including specialized assets, emotional ties,
government or social restrictions, strategic interrelationships with other business units,
labor agreements, or other fixed costs—which make competitors stay and fight even
when they find the industry unprofitable.

2.1 INDUSTRY ATTRACTIVENESS AND INDUSTRY SUCCESS FACTORS

 "Industry attractiveness is the presence or absence of threats exhibited by each of the industry
forces," Cook explained. "The greater the threat posed by an industry force, the less attractive
the industry becomes." Small businesses, in particular, should attempt to seek out markets in
which the threats are low and the attractiveness is high. Understanding what industry forces are
at work enables small business owners to develop strategies to deal with them. These
strategies, in turn, can help small businesses to find unique ways to satisfy their customers in
order to develop a competitive advantage over industry rivals.
 Success factors are those elements that determine whether a company succeeds or fails in a
given industry. They vary greatly by industry. Some examples of possible success factors include
quick response to market changes, a complete product line, fair prices, excellent product quality
or performance, knowledgeable sales support, a good record for deliveries, solid financial
standing, or a strong management team. "The reason for identifying success factors is that it will
 help lead you to areas where you can establish competitive advantages," Cook noted. The first
step is to determine whether or not the company possesses each success factor identified. Then
the small business owner can decide whether the company can and should develop additional
success factors.

3.1 THE IMPORTANCE OF INDUSTRY ANALYSIS

 A comprehensive industry analysis requires a small business owner to take an objective view
of the underlying forces, attractiveness, and success factors that determine the structure of
the industry. Understanding the company's operating environment in this way can help the
small business owner to formulate an effective strategy, position the company for success,
and make the most efficient use of the limited resources of the small business. "Once the
forces affecting competition in an industry and their underlying causes have been
diagnosed, the firm is in a position to identify its strengths and weaknesses relative to the
industry," Porter wrote. "An effective competitive strategy takes offensive or defensive
action in order to create a defendable position against the five competitive forces." Some of
the possible strategies include positioning the firm to use its unique capabilities as defense,
influencing the balance of outside forces in the firm's favor, or anticipating shifts in the
underlying industry factors and adapting before competitors do in order to gain a
competitive advantage.

III. How to Compare a Firm from other Business? (USA)

 One way in which to compare a particular business with the average of all participants in the industry is
through the use of ratio analysis and comparisons. Ratios are calculated by dividing one measurable
business factor by another, total sales divided by number of employees, for example.

By comparing a particular ratio for one company with that of the industry as a whole, a business owner
can learn much about where her business stands in comparison with the industry average. For example,
a small nursing home business can compare its "payroll per employee" ratio with the average for all
residential care operators in the U.S. in order to determine if it is within a competitive range. If her
business's "payroll per employee" figure is higher than the industry average, she may wish to investigate
further. Checking the "employees per establishment" ratio would be a logical place to look next. If this
ratio is lower than the industry average it may justifying the higher per-employee payroll figure. This
sort of comparative analysis is one important way in which to assess how one's business compares with
all others involved in the same line of work. There are various sources for the industry average ratios,
among them is the industry analysis series published by Thomson Gale as the USA series.

 Another premier model for analyzing the structure of industries was developed by Michael E. Porter in
his classic 1980 book Competitive Strategy: Techniques for Analyzing Industries and Competitors.
Porter's model shows that rivalry among firms in industry depends upon five forces: 1) the potential for
new competitors to enter the market; 2) the bargaining power of buyers; 3) the bargaining power of
suppliers; 4) the availability of substitute goods; and 5) the competitors and nature of competition.
These factors are outlined below.